Families with substantial assets should consider planning early to help determine the best way to pass on assets to their loved ones and manage any taxes or other expenses that may be payable.
In response to the growth of successful family-owned businesses across Canada, and the aging population, a new planning service has emerged called “Business Succession Planning."
Many business owners and entrepreneurs expect to transition the management or ownership of their businesses to the next generation. Those who aren’t thinking of passing down the business often contemplate selling or bringing in new shareholders. Yet, even with all these major changes being contemplated, many business owners simply do not have a formal succession plan in place.
Dying without a business succession plan can trigger a big tax bill. Consider the example of someone who immigrated to Canada with his spouse and two university-aged children in the late 1980s. After moving to Toronto, he invested in several retail shopping plazas and commercial buildings which he renovated and leased, taking advantage of the strengthening real estate market. Through hard work, risk taking and timing, the man amassed a property portfolio valued at $51 million today. The property is held in a Canadian holding company and he is the sole shareholder. The initial cost of his properties was around $21 million, and he therefore has a capital gain of $30 million.
He intends to leave his wife all of his assets and have her take over and run the rental property portfolio when he passes away. Canada’s tax laws allow him to leave his assets to his wife on a tax-free rollover basis.
He was advised to create a will. If a person passes away without one, the government has a set formula for how assets pass to heirs. Under the law in Ontario, his wife would not automatically inherit all his assets, as the set formula gives her the first $350,000 of his asset value and a further one-third of his assets, but the remaining two-thirds of his estate would go directly to their two grown children. While that first third of his estate would flow to his wife as a tax-free rollover, the two-thirds share of his assets passing to his children would cause an approximate $20 million capital gain (two-thirds of $30 million gain), and a tax bill of around $5 million.
The man was shocked by the tax estimate that awaited his estate and the reality that his wife would not automatically inherit all his properties if he passed away without a will.
There are practical solutions he can put in place now to mitigate some of the tax risks that await him. For example, he could consult a lawyer about putting a will in place to designate his wife as the beneficiary of his estate or make her the beneficiary of a trust set out in the will (testamentary trust). His wife may also want a similar will should her death precede his. These solutions could allow a deferral of the capital gains tax. He could also explore having multiple wills which could allow this person's private company shares (and certain other private assets he owns, including his rare watch and art collection) to bypass probate and save the 1.5% (approximate) probate fee in Ontario.
A will review is just one of the important areas covered in a comprehensive business succession plan. As well as a will, he is a candidate for an “estate freeze” and family trust strategies for his estate and tax planning. An estate freeze is a strategy that puts in place provisions to defer tax on an estate and to pay any tax that does arise from resources that don’t require the sale of principal assets. This helps the beneficiaries who can’t easily sell or don’t want to sell certain assets, such as a business or family cottage. In this example, it was possible to estimate the ultimate final capital gains tax liability payable on who dies last — either himself or his wife — and purchase corporate-owned life insurance to pay the income taxes arising at death. This would allow his heirs to inherit the company assets without having to sell or encumber them to pay the tax.
With the growing numbers of successful entrepreneurs and real estate investors living in Canada from abroad, many may not be aware of Canada’s tax laws. Many may not know about the deemed disposition on death, the importance of having a will in place or the consequences that await their survivors in the absence of a well-thought-out succession and estate plan.
Given that a family business or real estate portfolio may be the single most valuable family asset, it is critical to develop an orderly succession plan, as early as possible.